Understanding Real Estate Finance

Understanding Real Estate Finance by Dan Palmier

The real estate sector has been intrinsically tied to the American economy for centuries. It is sometimes said that all property owners in the United States are investors at heart; this adage is confirmed by the considerable number of real estate transactions that close each day.
For most individuals, acquiring real estate is not something that they can accomplish by means of writing a check; most residential properties in the U.S. have at least one mortgage attached to them, and a similar situation can be observed in commercial buildings. In other words, the bottom line of American real estate is that it often requires some type of financing, which could be granted for acquisitions, refurbishing, construction, development, leverage, and more.

In essence, real estate financing is an economic activity that seeks to fund property acquisitions and other operations in exchange for interest payments as well as a favorable lien position on collateral property.

The most prominent segment of American real estate finance is the residential mortgage lending industry. In 2015, housing analytics firm CoreLogic estimated that the size of the U.S. mortgage market could be as high as $1,36 trillion on an annual basis. While the bulk of loan origination activity in this segment is carried out for the purpose of occupying the dwelling, there is a fair amount of lending to residential property investors.

After the U.S. housing market, the commercial real estate market was estimated to produce revenues in excess of $2.3 billion per year. The financing of commercial real estate is more dynamic, flexible and complex than its residential counterpart, and the opportunities for profit are greater. It is interesting to note that U.S. President Donald Trump’s early fortune was made in the commercial real estate segment.

Government loan guarantees and investment backing are two of the reasons why the American housing market is considerably larger than the commercial real estate segment. In general, it is more expensive to secure financing for commercial properties, and investors take on greater risks than with residential financing.

Home lending is far more conventional than commercial real estate financing, although exotic bridge, portfolio and bridge loans are available to prospective homeowners. The commercial property segment presents more investment opportunities such as mezzanine financing, which mixes debt with equity interest in a property.

Amortization is possible with commercial real estate lending, although balloon features are common. Takeout and conduit loans can be secured on a secondary market for the purpose of settling debts owed to construction firms or to place a permanent lien on a property that is generating revenue and appreciating in value.

Daniel Palmier is a leading Boston CEO, Real Estate Investment Manager, and Founder of UC Funds.

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